The following is our discussion and analysis of certain significant factors that have affected our financial position and operating results and those of our subsidiaries, Appalachian Community Bank (the "Bank") and Appalachian Community Bank, F.S.B. (the "Thrift"), during the periods included in the accompanying financial statements. This commentary should be read in conjunction with the financial statements and the related notes and the other statistical information included in this report.

This report contains "forward-looking statements" relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by and information currently available to management. The words "may," "will," "anticipate," "should," "would," "believe," "contemplate," "expect," "estimate," "continue," "may," and "intend," as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties that are discussed in detail in our filings with the Securities and Exchange Commission, including, without limitation:

• significant increases in competitive pressure in the banking and financial services industries;

• changes in the interest rate environment which could reduce anticipated or actual margins;

• changes in political conditions or the legislative or regulatory environment;

• general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;

• changes occurring in business conditions and inflation;

• changes in technology;

• the level of allowance for loan loss;

• the rate of delinquencies and amounts of charge-offs;

• the rates of loan growth;

• adverse changes in asset quality and resulting credit risk-related losses and expenses;

• changes in monetary and tax policies;

• loss of consumer confidence and economic disruptions resulting from terrorist activities;

• changes in the securities markets; and

• other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.

Overview

We were incorporated in 1996 to serve as the bank holding company for Appalachian Community Bank (formerly Gilmer County Bank), a state-chartered bank located in the foothills of the Blue Ridge Mountains in North Georgia. We are headquartered in Ellijay, Georgia, and, in March 2006, we opened our new headquarters and operations center, also located in Ellijay. Since April 2007, we also serve as the holding company for Appalachian Community Bank, F.S.B., a federally-chartered thrift. Our primary market areas are Gilmer, Union, Fannin, Murray, Dawson, Lumpkin and Whitfield Counties, Georgia, and nearby Polk County, Tennessee, and Cherokee County, North Carolina. We provide a full range of community banking services, through the Bank and the Thrift, to individuals and small- to medium-sized businesses located within our market areas, through thirteen full-service branches in Ellijay, East Ellijay, Blue Ridge, Blairsville, Chatsworth, Dawsonville, McCaysville, Dahlonega and Dalton, Georgia, as well as Murphy, North Carolina and Ducktown, Tennessee. The following discussion describes our results of operations for the three months and six months ended June 30, 2008, as compared to the three months and six months ended June 30, 2007, and also analyzes our financial condition as of June 30, 2008, as compared to December 31, 2007.

Like most community banks and thrifts, we derive the majority of our income from interest and fees received on our loans. Our primary source of funds for making loans and for the purchase of investments is our deposits, on the majority of which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income earned on our interest-earning assets, such as loans and investments, and the interest paid on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread.

Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We maintain this allowance by charging a provision for loan losses against our earnings. We have included in this section a detailed discussion of this process.

In addition to earning interest on our loans and investments, we earn income through fees and other charges to our customers. We have also included a discussion of the various components of this noninterest income, as well as of our noninterest expense.

The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in this report.

Critical Accounting Policies

In the preparation of our consolidated financial statements, we have adopted various accounting policies that govern the application of GAAP in the United States as well as the general practices within the banking industry. Our significant accounting policies are described in the notes to our audited consolidated financial statements as of December 31, 2007, as filed in our Annual Report on Form 10-K.

Certain accounting policies involve significant judgments and assumptions by management which may have a material impact on the carrying value of certain assets and liabilities. We consider such accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates. These differences could have a material impact on our carrying values of assets and liabilities and our results of operations.

We believe the determination of the allowance for loan losses is the critical accounting policy that requires the most significant judgments and estimates when preparing our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, cash flow assumptions, the determination of loss factors for estimating credit losses, the impact of current events and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management's estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

Results of Operations

Income Statement Review

Three and six months ended June 30, 2008 and 2007

Overview

Our net income for the six months ended June 30, 2008 was $1.8 million, compared to net income of $3.1 million for the same period in 2007, a decrease of 39.9%. Our net income for the three months ended June 30, 2008 was $701,000, compared to net income of $1.5 million for the same period in 2007, a decrease of 53.3%. Basic and diluted earnings per share were $0.34 for the six months ended June 30, 2008 and $0.13 for the quarter ended June 30, 2008, compared to $0.58 for the six months ended June 30, 2007 and $0.29 for the quarter ended June 30, 2007. Return on average assets was 0.37% for the six months ended June 30, 2008 and 0.28% for the quarter ended June 30, 2008, compared to 0.75% for the six months ended June 30, 2007 and 0.71% for the quarter ended June 30, 2007. Return on average equity was 4.89% for the six months ended June 30, 2008 and 3.70% for the quarter ended June 30, 2008, compared to 9.04% for the six months ended June 30, 2007 and 8.68% for the quarter ended June 30, 2007. Our net interest margin was 4.18% and 4.07% for the six months and quarter ended June 30, 2008, compared to 4.86% and 4.83% for the six months and quarter ended June 30, 2007. Our decrease in net income for the six months and the quarter ended June 30, 2008 was primarily due to our provision for loan losses, losses on sales of other real estate ("ORE"), as well as increased other operating expenses necessary to support our company's growth.

Net Interest Income

Our primary source of revenue is net interest income, which represents the difference between the income on interest-earning assets and expense on interest-bearing liabilities. During the first six months of 2008, net interest income increased $946,000, or 5.2%, to $19.3 million, compared to $18.3 million for the same period in 2007. For the three months ended June 30, 2008, net interest income increased 1.1% to $9.5 million, from $9.4 million during the comparable period in 2007. The increase in net interest income for the six months ended June 30, 2008 reflects the continued growth in loans as average net loans increased to $840.7 million during the first half of 2008 from $679.7 million during the same period in 2007. Total revenue, net of interest expense, was $21.9 million and $10.9 million for the six months and three months ended June 30, 2008, respectively. This represented an increase of 4.4% and 1.7% over the same periods in 2007. The revenue growth continues to be primarily the result of the growth in our loan portfolio.

The net interest margin, or the net yield on earning assets, is computed by dividing taxable equivalent net interest income by average earning assets. This ratio represents the difference between the average yield returned on average earning assets and the average rate paid for funds used to support those earning assets. The taxable equivalent net interest margin was 4.18% for the six month period ended June 30, 2008 compared to 4.86% for the same period in 2007. Net interest spread, the difference between the rate we earn on interest-earning assets and the rate we pay on interest-bearing liabilities, was 3.90% for

the first six months of 2008 compared to 4.39% during the same period for 2007. Since December 31, 2007, the Prime rate has dropped a total of 2.25%. Prime has dropped 3.25% since June 30, 2007. These decreases lowered the yield on earning assets more rapidly than it lowered the cost of funds. The interest rate margin compression continues to be a banking industry concern. However, we continue to maintain net interest margin levels, which are driven by our balance sheet mix and operating markets that are above average based on our peers. Also, as our current temporary branch locations are converted to permanent banking facilities in our expansion markets, deposit growth in these markets will allow us to replace alternative funding sources with core deposits. During the first half of 2008 we began construction to replace two of our current temporary locations and plan to begin the conversion of another temporary branch location to a permanent facility in the last half of 2008.

The following table shows, for the six months ended June 30, 2008 and 2007, information related to our average balance sheets, average yields on assets, and average costs of liabilities. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated.

                                             For the Six Months Ended           For the Six Months Ended
                                                  June 30, 2008                      June 30, 2007
                                                                 Yields/                            Yields/
                                           Average    Income/     Rates       Average    Income/     Rates
                                           Balance    Expense      (4)        Balance    Expense      (4)
                                                               (Dollars in thousands)
Earning assets:
Loans, net of unearned income (1)         $ 840,737   $ 33,936      8.10 %   $ 679,664   $ 32,546      9.66 %
Mortgage loans held for sale                  4,332        114      5.28         2,573         75      5.88
Investment securities (2) (3)                80,922      2,073      5.14        76,294      1,873      4.95
Interest-bearing deposits                       723          8      2.22         2,454         64      5.26
Federal funds sold                            8,378         98      2.35         5,403        153      5.71

Total interest-earning assets (3)         $ 935,092     36,229      7.77     $ 766,388     34,711      9.13


Interest-bearing liabilities:
Demand deposits                           $  58,802        544      1.86     $  72,033        852      2.39
Savings deposits                            203,362      2,795      2.76       160,828      3,440      4.31
Time deposits                               526,950     11,919      4.54       409,375     10,814      5.33

Total deposits                              789,114     15,258      3.88       642,236     15,106      4.74

Other short-term borrowings                  15,273        245      3.22         7,569        112      2.98
Long-term debt                               65,781      1,290      3.93        40,430      1,008      5.03

Total interest-bearing liabilities        $ 870,168     16,793      3.87     $ 690,235     16,226      4.74


Net interest income/net interest spread                 19,436      3.90 %                 18,485      4.39 %


Net yield on earning assets                                         4.18 %                             4.86 %

Taxable equivalent adjustment:
Loans                                                       12                                 15
Investment securities                                      174                                166

Total taxable equivalent adjustment                        186                                181


Net interest income                                   $ 19,250                           $ 18,304

(1) Average loans exclude average nonaccrual loans of $4.2 million and $2.1 million for the six months ended June 30, 2008 and 2007, respectively. All loans and deposits are domestic.

(2) Taxable equivalent.

(3) Average securities exclude average unrealized gains of $884,000 and unrealized losses of $390,000 for the six months ended June 30, 2008 and 2007, respectively.

(4) Annualized.

Provision for Loan Losses

The provision for loan losses is based on the growth of the loan portfolio, the amount of net loan losses incurred and management's estimation of potential future losses based on an evaluation of the risk in the loan portfolio. The provision for loan losses was $2.5 million and $1.6 million for the six months ended June 30, 2008 and 2007, respectively. For the three months ended June 30, 2008 and 2007, the provision for loan losses was $1.5 million and $947,000, respectively. The increase in the provision for loan losses for the six and three month periods ended June 30, 2008 over the same periods in 2007 was due to increases in total loans, nonperforming loans, as well as increases in net charge-offs - primarily in real estate-construction loans. We continue to carefully monitor real estate-construction loans to identify any potential new loan losses, charge-offs related to all types of loans, and liquidation of foreclosed assets in a timely manner. Please see the discussion below under "Allowance for Loan Losses" for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.

Noninterest Income

Noninterest income for the six months ended June 30, 2008 was $2.6 million, consistent with the same period in 2007. Noninterest income increased $82,000 or 6.5%, for the three months ended June 30, 2008, as compared to the same period in 2007. These amounts are primarily from customer service fees, mortgage origination commissions, earnings on cash surrender value of life insurance, insurance commissions, as well as other fees charged to customers such as safe deposit box rental and ATM fees. Customer service fees, the largest component of noninterest income, increased $163,000, or 15.4%, to $1.2 million for the first six months of 2008 from $1.1 million during the same period of 2007. For the three months ended June 30, 2008, customer service fees increased $112,000 or 20.4%, as compared to the same period in 2007. The increase in customer service fees is primarily related to the deposit account growth in new markets. Additionally, our continuing efforts to increase the amount of deposit account charges, including non-sufficient funds (NSF) charges and returned check charges, have had a positive effect on noninterest income. Mortgage origination commissions decreased by $129,000 for the first six months of 2008, and decreased by $14,000 for the three months ended June 30, 2008, as compared to the same periods in 2007. The decrease in mortgage origination commissions relates primarily to the decline in the mortgage activity for these periods in 2008, compared to the same periods in 2007. Other operating income decreased by $68,000 for the first six months of 2008, as compared to the same period in 2007. For the three months ended June 30, 2008, other operating income decreased by $16,000 compared to the same period in 2007.

Noninterest Expenses

Noninterest expenses totaled $16.8 million for the first six months of 2008, up from $14.7 million for the same period in 2007. Salaries and employee benefits increased $1.1 million or 12.3%, to $10.0 million for the first six months of 2008, compared to the same period in 2007. This increase in salaries and employee benefits was primarily due to the additional staff necessary to support our continued market growth and our expansion into new markets, as well as the addition of several management-level employees necessary to provide the infrastructure to support our continued growth. Since June 30, 2007, we have added 20 full-time equivalent employees. The three month increases in noninterest expenses are consistent with increases discussed for the six months ended June 30, 2008.

Occupancy, furniture and equipment expenses totaled $2.1 million for the first six months in 2008, compared to $1.8 million for the same period in 2007. The 19.2% increase is primarily due to our expansion efforts. As of June 30, 2008, our occupancy, furniture and equipment expenses included two full quarters of depreciation expense on the new Dawsonville facility, as well as five months depreciation on the new Chatsworth facility, which opened in February 2008. In 2007, we operated our Chatsworth and Dawsonville locations out of less-expensive, but less-effective, leased facilities.

Other operating expenses increased $620,000 to $4.6 million for the six months ended June 30, 2008, compared to $4.0 million for the same period in 2007. This increase is primarily the result of increased losses on sales of ORE, increases in state regulatory examination fees, FDIC deposit-insurance costs, amortization costs, and data processing costs. We had net losses on sales of ORE of approximately $392,000 during the first half of 2008, compared to an ORE net loss of $5,000 reported in noninterest income in the same period of 2007. Our FDIC deposit-insurance and state regulatory examination costs increased $284,000, over the same period in 2007, due primarily to the increase in our deposit-insurance assessments which did not occur until the third quarter of 2007, as well as the increase in premiums relating to our growth in deposits as compared to the same period in 2007. Amortization expense increased by $106,000 primarily due to a non-compete agreement entered into in October 2007 with a former employee which ended in March 2008. Increased data processing expenses, as well as various other expense increases, were required to support our market growth and new branches. These costs were offset in part by $178,000 decrease in promotional and advertising expense, as well as various other expense decreases resulting from management's efforts to keep other costs at a minimum without sacrificing service to our customers.

Income Taxes

The provision for income taxes for the six months ended June 30, 2008 was $780,000, a decrease of $781,000 compared to the same period in 2007. The decrease in the provision is due to the decrease in net income for the first six months of 2008, as compared to the same period in 2007. The effective tax rates were 29.8% and 33.8% for the six months ended June 30, 2008 and 2007, respectively. For the three months ended June 30, 2008, the provision for income taxes was $255,000, a decrease of $556,000, compared to the same period in 2007. The effective tax rates were 26.7% and 35.1% for the three months ended June 30, 2008 and 2007, respectively. The effective tax rates have decreased due to fact that although net income has dropped, nontaxable income amounts have remained consistent over the same periods in 2008.

Balance Sheet Review

General

At June 30, 2008, we had total assets of $1.1 billion, an increase of $88.7 million, or 9.1%, from $971.2 million, at December 31, 2007. Cash and cash equivalents increased $25.3 million, or 95.3% from December 31, 2007, to $51.8 million at June 30, 2008. Our total loans increased $62.1 million, or 7.7%, from December 31, 2007, to $869.6 million at June 30, 2008. Securities available-for-sale increased from $80.5 million at December 31, 2007, to $80.7 million at June 30, 2008, or 0.3%. Net premises and equipment increased $2.3 million, or 7.1%, since December 31, 2007, to $35.3 million at June 30, 2008.

Our liabilities at June 30, 2008 totaled $983.9 million, which was an increase of 9.6% over total liabilities at December 31, 2007. Total deposits were $903.1 million at June 30, 2008, which was a 11.8% increase over the December 31, 2007 balance of $807.6 million. Federal Home Loan Bank advances decreased $200,000 or 0.4% since December 31, 2007. Short-term borrowings decreased $9.2 million or 43.9% since December 31, 2007.

Shareholder's equity at June 30, 2008 totaled $75.9 million, which was a 3.1% increase over the December 31, 2007 balance of $73.7 million.

Federal Funds Sold

Federal funds sold at June 30, 2008 and December 31, 2007 were $23.8 million and $12.8 million, respectively, an increase of $11.0 million. The increase in federal funds resulted from the timing of the increase in core deposits in advance of the funding of loans and paying off wholesale funding. We continue to try to minimize federal funds sold to maximize our use of earning assets.

Securities Portfolio

Total investment securities averaged $80.9 million during the first six months of 2008 and totaled $80.7 million at June 30, 2008. Total investment securities averaged $76.3 million during the first six months of 2007 and totaled $80.5 million at December 31, 2007. At June 30, 2008, our total investment securities portfolio had an unrealized net loss of $198,000 compared with an unrealized net gain of $426,000 at December 31, 2007.

Loan Portfolio

Loans make up the largest component of our earning assets. At June 30, 2008, our total loans were $869.6 million, compared to loans of $807.5 million as of December 31, 2007, an increase of 7.7%. As of June 30, 2008, average loans represented 89.9% of average earning assets compared to 88.7% at June 30, 2007. Average loans increased to $840.7 million (excluding average nonaccrual loans of $4.2 million) with a yield of 8.10% in the first six months of 2008, from $679.7 million (excluding average nonaccrual loans of $2.1 million) with a yield of 9.66%, since June 30, 2007. The decrease in the yield on loans is primarily due to significant rate decreases initiated by the Federal Reserve during the first half of 2008. The Prime rate averaged 5.63% for the six months ended June 30, 2008 versus 8.25% for the same period in 2007. We continue to see a demand for loans, although at a slower than normal rate. Acquisition, development and construction loans increased 2.5% during the period from December 31, 2007 to June 30, 2008; however, this loan category increased 19.4% during the same period in 2007. Consistent with much of the country, the residential real estate market in North Georgia has slowed considerably, and it is estimated that there is between a 24 and 36 month supply of housing on the market. Our business model, which includes having strong connected local bankers in each of our geographic markets, gives us a unique ability to monitor loan activity and credit quality.

Allowance for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged as an expense on our income statement. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions, which we believe to be reasonable, but which may or may not prove to be accurate. In assessing adequacy, management relies predominantly on its ongoing review of the loan portfolio, which is undertaken both to determine whether there are probable losses that must be charged off and to assess the risk characteristics of the aggregate portfolio. This review takes into consideration the judgments of the responsible lending officers and senior management, external loan review, and also those of bank regulatory agencies that review the loan portfolio as part of the regular bank examination process. In evaluating the allowance, management also considers our loan loss experience, the amount of past due and nonperforming loans, current economic conditions, lender requirements and other appropriate information. Certain nonperforming loans are individually assessed for impairment under Statement of Accounting Financial Accounting Standards ("SFAS") No. 114 and assigned specific allocations. All other loans are evaluated based on quantitative and qualitative risk factors.

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